Allotment of Securities by Unlisted Companies under Companies Act, 2013

A.  INTRODUCTION:

Funding is crucial for corporate, not only to invest and to expand, but also to operate their daily business. When a company needs to raise funds, it may look at various options: debt, equity, venture capital, etc. Equity capital is funds paid into business by investors in exchange of common or preferred stock. An alternative form of capital is debt financing by issuing various bonds, debentures, bills or notes.

The Companies Act, 2013 have laid down varied conditions and procedures for issue of various securities and debt instruments by an unlisted company. In this article, we have dealt with the procedural aspects and practical insights on issue of shares on rights basis, private placement of securities, issue of shares on preferential basis, issue of employee stock options, issue of preference shares and issue of debentures and their valuations by an unlisted company.

B. RIGHTS ISSUE:

An unlisted company planning for a rights issue need to look into Section 62(1)(a) of Companies Act, 2013. Rights issue is an issue of shares at a specified price by a company to its existing shareholders in proportion to their existing shareholding. The following conditions needs to be followed by a company for issue of shares on rights basis:

• An offer shall be made by the company by a notice addressing to respective shareholders specifying the number of shares offered. The offer letter is to be approved by the Board of Directors. Further, there is no specific format of offer letter is prescribed under law.
• The issue price is the price determined by the Company and hence no valuation of securities is required.
• Offer shall be open for a minimum of 15 days and a maximum of 30 days from the date of offer. However, in private companies the offer period can be less than 15 days with the consent of 90% of shareholders.
• The notice shall be dispatched through registered post or speed post or through electronic mode or courier or any other mode having proof of delivery at least 3 days before the opening of the issue.
• Return of allotment along with complete list of allottees to be filed within 30 days from the date of allotment with the Registrar of Companies.

Unless the articles of the company otherwise provide, the offer shall be deemed to include rights to renounce the shares in favor of any other person and the notice shall contain the statement of his right. Thus, allotment of shares through rights basis allows a company to allot its shares to any person other than existing shareholder without valuation of shares by a registered valuer and shareholders’ approval, subject to renunciation of shares by the existing shareholder to any person not being the existing shareholder.

C. PRIVATE PLACEMENT:

Private placement means any offer or invitation to subscribe or issue of securities to a select group of persons who have been identified by the Board (other than by way of public offer) through private placement offer-cum-application. Private Placement of Securities is covered under Section 42 read with Rule 14 of Companies (Prospectus and Allotment of Securities) Rules, 2014. The following conditions need to be followed by an unlisted company to issue securities through private placement:

• Private Placement of each kind of securities shall be made to persons not exceeding 200 in a financial year excluding the qualified institutional buyers and employees under the employee stock option scheme.
• The offer shall be authorized by articles of association of the company and shall be approved by shareholders of the company by a special resolution.
• In the explanatory statement annexed to the notice for shareholders approval, the following disclosures to be made. (a) Particulars of the offer including passing of Board resolution and the total amount of money company intends to raise. (b) Kinds of securities offered and the price at which offered along with the basis and justification of price including premium, if any. (c) Name and address of Registered Valuer who performed valuation. (d) Material terms of raising such securities, proposed time schedule, purposes or objects of offer, contribution being made by the promoters or directors either as part of the offer or separately in furtherance of objects; principle terms of assets charged as securities.
• The Company shall not issue any securities less than the value determined by the Registered Valuer. In case the allotment is made to any non – resident Indian, the issue price to be worked out as per internationally accepted pricing methodology, duly certified by a SEBI Registered Merchant banker or a Chartered Accountant or a Cost Accountant in practice.
• The company shall issue offer cum application letter only after the resolution approved by the shareholders has been filed with the registry in Form MGT-14.
• The private placement offer cum application letter shall be in the form of an application in Form PAS-4, serially numbered and addressed specifically to the persons to whom the offer is made, either in writing or electronic mode within 30 days of recording of name of such person.
• The subscription money to be paid either through cheque or demand draft or other banking channel and not in cash.
• The monies received on application of securities shall be kept in a separate bank account and shall not be utilized other than for adjustment against allotment, or for repayment of monies in case of failure to allot securities.
• The company making an offer shall allot its securities within 60 days from the date of receipt of application money. If the company fails to allot the securities, shall return the subscription money within 15 days from the expiry of sixty days and if it fails to repay shall be liable to repay with interest of 12% p.a. after the expiry of sixtieth day.
• The company needs to file return of allotment along with a complete list of allottees and valuation report within 15 days from the date of allotment in Form PAS-3.
• The monies raised by the company by allotment shall be utilized by the company only after approval of Form MGT-14 filed with the Registrar of companies and filing of Form PAS-03 for allotment of shares.
• If a company defaults in filing the return of allotment within the period prescribed, the company, its promoters and directors shall be liable to a penalty for each default of one thousand rupees for each day during which such default continues but not exceeding twenty-five lakh rupees.
• No fresh offer or invitation shall be made unless the allotment with respect to earlier offer or invitation have been completed or abandoned.
• The company shall maintain the complete record of private placement in Form PAS-5 and is to be filed with Registrar of Companies along with the return of Allotment in Form PAS-03.
• If a company makes an offer or accepts monies in contravention of this section, the company, its promoters and directors shall be liable for a penalty which may extend to the amount raised through the private placement or two crore rupees, whichever is lower, and the company shall also refund all monies with interest as specified in sub-section (6) to subscribers within a period of thirty days of the order imposing the penalty.

D. ISSUE OF SHARES ON PREFERENTIAL BASIS:

Preferential issue is an issue of shares or convertible securities by a company to a select group of persons under section 62 (1) (c) of the Companies Act, 2013 read with Rule 13 of Companies (Share Capital and Debentures) Rules, 2014 which is neither a rights issue nor public issue. The following are the conditions laid down under the Act.

• The issue is authorized by members by special resolution.
• Issue of shares on a preferential basis shall also comply with conditions laid down in section 42 of the Act except if the issue is to existing members only.
• The issue may be either for cash or for a consideration other than cash.
• The price for issue of shares shall be determined by a Registered Valuer.
• The company need to make the disclosures in the explanatory statement to be annexed to notice of general meeting as mentioned in Rule 13 (2) of Companies (Share Capital and Debentures) Rules, 2014.
• The allotment of securities shall be completed within a period of 12 months from the date of passing of special resolution.
• Where convertible securities are offered within an option to apply for and get equity shares, the price of the resultant shares shall be determined – Either upfront at the time when offer of convertible securities is made on the basis of the valuation report of registered valuer, or at the time, which shall not be earlier than 30 days to the date when the holder of convertible security becomes entitled to apply for shares, on the basis of valuation report of the registered valuer given not earlier than sixty days of the date when the holder of convertible security becomes entitled to apply for shares.
• where shares or other securities are to be allotted for consideration other than cash, the valuation of such consideration shall be done by a registered valuer who shall submit a valuation report to the company giving justification for the valuation.

E. ISSUE UNDER A SCHEME OF EMPLOYEES STOCK OPTION:

The very purpose of the Employee Stock Option Plan (ESOP) or Employee Stock Option Scheme (ESOS) is to motivate employees through ownership in company by way of equity. “Employees’ stock option” means the option given to the directors, officers or employees of a company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price. Section 62(1) (b) read with rule 12 of Companies (Share capital and Debentures) Rules, 2014 deals with the provisions for issue of Employee Stock Options.

• Issue of Employee Stock Options is through a Scheme approved by members of the company by special resolution. However for private companies the scheme is approved by members by ordinary resolution.
• Employee: “Employee” as per section 62(1)(b) and rule 12, “Employee” is as follows:
  • A permanent employee of the company who has been working in India or outside India; or
  • A director of the company, whether a whole time director or not but excluding an independent director; or
  • An employee as defined in clause (a) or (b) of a subsidiary, in India or outside India, or of a holding company of the company or of an associate company, but does not include- (a) an employee who is a promoter or a person belonging to the promoter group; or (b) a director who either himself or through his relative or through any corporate, directly or indirectly, holds more than 10% of the outstanding equity shares of the company.
• Start-ups may issue the shares under ESOP to their promoters and directors who hold more than 10% for the 10 years from the date of their incorporation. The restriction on issuing shares under ESOP to promoters and such directors continues for companies which do not fall under the category of start-ups.
• The company need to make the disclosures in the explanatory statement to be annexed to notice of general meeting as mentioned in Rule 12 (2) of Companies (Share Capital and Debentures) Rules, 2014.
• The company may by special resolution, vary the terms of Employees Stock Option Scheme not yet exercised by the employees provided such variation is not prejudicial to the interests of the option holders.
• The company shall maintain a Register of Employee Stock Options in Form No. SH.6 and shall enter therein the particulars of option granted.
• The minimum vesting period shall be of one year.
• The company has the freedom to specify the lock-in period for the shares issued pursuant to exercise of option.
• The Employees has no rightto receive any dividend or to vote or in any manner enjoy the benefits of a shareholder during the period from grant of option till issue of shares on exercise of option.
• The amount payable by the employees, at the time of grant of option, if any may be forfeited by the company if the option is not exercised by the employees within the exercise period; or may be refunded to the employees if the options are not vested due to non-fulfilment of conditions relating to vesting of option as per the ESOS.
• The option granted to employees are neither transferable to any other person nor to be pledged, hypothecated, mortgaged or otherwise encumbered or alienated in any other manner.

Exercise of options:

• No person other than the employees to whom the option is granted is entitled to exercise the option.
• In the event of the death of employee while in employment, all the options granted to him till such date shall vest in the legal heirs or nominees of the deceased employee.
• In case the employee suffers a permanent incapacity while in employment, all the options granted to him as on the date of permanent incapacitation, shall vest in him on that day.
• In the event of resignation or termination of employment, all options not vested in the employee as on that day shall expire. However, the employee can exercise the options granted to him which are vested within the period specified in this behalf, subject to the terms and conditions under the scheme as approved by the Board.
• The Board of directors shall disclose in the Directors’ Report for the year, the details of the Employees Stock Option Scheme.

In the recent past, Indian companies are entering into cash settled schemes like Share Appreciation Rights (SARs) or Phantom Stocks, as they cannot issue ESOPs to non-employees and as a way of rewarding the promoters, advisors, consultants and non-employees. While the ESOPs form part of company capital, cash settled schemes do not. These types of schemes have not been recognized under Companies Act, 2013.

F. ISSUE OF PREFERENCE SHARES:

Issue and redemption of preference shares is governed by Section 55 of the Companies Act, 2013 read with rule 9 of Companies (Share Capital and Debentures) Rules, 2014.

• No company shall issue any preference shares which are irredeemable The maximum tenure for issue of preference shares is twenty years.. Infrastructure companies may issue redeemable preference shares exceeding twenty years but not exceeding thirty years subject to minimum redemption of 10% of preference shares each year starting form twenty first year onwards on proportionate basis.
• Preference shares shall be redeemed: Only if they are fully paid; Out of the profits of the company which would otherwise be available for dividend or out of fresh issue of shares made for the purpose of such redemption; If redeemed out of profits, a sum equal to the nominal capital of shares to be redeemed, be transferred to Capital Redemption Reserve Account.
• Issue of such shares shall be approved by the members of the company by special resolution.
• The company at the time of issue shall have no subsisting default in the redemption of preference shares or in payment of dividend on any preference shares.

Method of Issue of Preference Shares: An unlisted company may issue preference shares either through

• Rights Issue under Section 62(1) (a) only to existing shareholders
• Stock Options under section 62(1) (b) specifically to the employees under the scheme
• Preferential Allotment under Section 62(1) (c) to any person
• Private Placement under Section 42 of the Act.

Note: An unlisted company issuing preference shares through any of the methods mentioned hereinabove also need to comply with the procedures and conditions mentioned in the respective sections and as already reproduced in this article.

G. ISSUE OF DEBENTURES:

Debentures include debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not. Section 71 of the Act and rule 18 of Companies (Share Capital & Debenture) Rules, 2014 deals with the provisions relating to the issuance of Non-Convertible Debentures. The following are the specific provisions to be kept in mind while issuing Debentures:

• Board of Directors of the Company pursuant to section 179(3) of the Act has a right to issue non-convertible debentures.
• Debentures cannot be issued with voting rights.
• An issue of secured debentures may be made, up to a maximum redemption period of ten years from the date of issue otherwise would be considered as deposits. In the case of a company engaged in the setting up of infrastructure projects such period of redemption may exceed a period of ten years but cannot exceed thirty years.
• Issue of secured debentures shall be secured by the creation of a charge, on the properties or assets of the company, having a value which is sufficient for the due repayment of the amount of debentures and interest thereon. The company need to file with the registrar of companies for creation of charge in Form CHG-9.
• the security for the debentures by way of a charge or mortgage shall be created in favour of the debenture trustee on: any specific movable property of the company (not being in the nature of pledge); or any specific immovable property wherever situate, or any interest therein.
• In case of NBFC Companies, the charge or mortgage may be created on movable property. Further in case of any issue of debentures by Government Company which is fully secured by the guarantee given by Central Government or one or more State Government or both, the requirement for creation of charge shall not apply.
• In case of any loan taken by a subsidiary company from any bank or financial institution the charge or mortgage may also be created on the properties or assets of the holding company.
• On issue of debentures, the company shall create a debenture redemption reserve account out of the profits of the company available for payment of dividend and the amount credited to such account shall not be utilised by the company except for the redemption of debentures.
• The company cannot issue debentures to more than five hundred persons, unless the company has, before such issue or offer, appointed debenture trustee, whose primary duty would be to protect the interest of debenture holders and redress their grievances.
• A company shall pay interest and redeem the debentures in accordance with the terms and conditions of their issue. Hence it is noted that a company can issue debentures at a zero percent interest rate.
• Where a company fails to redeem the debentures on the date of their maturity or fails to pay interest on the debentures when it is due, the Tribunal may, on the application of any or all of the debenture-holders, or debenture trustee and, after hearing the parties concerned, direct, by order, the company to redeem the debentures forthwith on payment of principal and interest due thereon.
• If any default is made in complying with the order of the Tribunal under this section, every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to three years or with fine which shall not be less than two lakh rupees but which may extend to five lakh rupees, or with both.

Method of Issue of Debentures: An unlisted company may issue debentures either through

• Rights Issue under Section 62(1) (a) only to existing shareholders
• Preferential Allotment under Section 62(1) (c) to any person
• Private Placement under Section 42 of the Act.

Note: An unlisted company issuing debentures shares through any of the methods mentioned hereinabove need to also comply with the procedures and conditions mentioned in the respective sections and as already reproduced in this article.

H. OTHER ASPECTS FOR ISSUE OF SECURITIES:

An unlisted company shall look into following additional aspects to issue and allot securities:

• Authorized Capital: Company to check that the authorized capital of the company is adequate for issue of shares.
• Share Certificate: Company to issue share certificate within two months from the date of allotment.
• Stamp Duty: Company has to pay stamp duty on issue of certificate including debenture certificate. The Stamp duty payable on shares is not mentioned under union list and hence, the States have power to impose stamp duty. In case of debentures, the item is included in union list and the amount of stamp duty payable is identical all over India.
• Valuation Report to be attached in form PAS-03: Company to mandatory attach valuation report in form PAS-03 except in case of shares on rights basis.
• Penalty for non filing of Return of Allotment in Form PAS-03: In case of any default in filing Return of Allotment, the company and its officers who is default is liable to penalty, for each default, of one thousand rupees for each day during such default continues or one lakh rupees, whichever is less.

Authors: Prashant Jain, Co-Founder & Partner; Prajakta V. Gokhale, Associate; Nisha Jhawar, Associate.

Disclaimer: The content of this article is intended to provide a general guide to the subject matter. For any queries, the authors can be reached at (i) prashant@samistilegal.in (ii) prajakta@rna-cs.com (iii) nisha@rna-cs.co.in.